In the early days of most of our businesses, we will normally lease space from a landlord. Yes, there are other options like WeWork or Regis available these days for certain kinds of businesses. But I'm specifically focusing on what entrepreneurs need to better understand if they choose to sign a multi-year lease for space for your team.
Any time you sign a lease--which is often a fairly complicated contract--you'll want an experienced real estate lawyer to help you understand the nuances. But, as a CEO, there are a couple of areas where you really need to focus because they are the critical few that absolutely impact the long-term financial health of your business.
1. Base Lease Payment
A lease payment is normally expressed as an amount of dollars per square foot per year. A basic warehouse, for example, might cost $8-$10 a square foot per year--or closer to a $1 a square foot on a monthly basis. If you want to rent a desirable retail location on a street in a mid-size city, on the other hand, you might be looking at $40, $50, or even higher price per square foot. For comparison, Class A office space in a decent city might cost you between $40 and $100 per square foot, depending on the amenities offered. Best practice is to obviously try and negotiate the lowest price you can as the term of a lease usually runs from three to ten years. When you get the initial base lease payment figure, make sure it is with zero Tennant Improvements (see below) and negotiate from there.
2. Escalator Clause
Every lease has what's called an "escalator clause," which is basically the right for the landlord to increase your rent by a certain percentage each year--something that is typically 2% to 3% per year. While that might not seem like a big deal, thanks to the miracle of compounding interest, it could be. If you sign a lease where you pay $20 per square foot and your landlord increases the rent 3% each year, you'll be paying $26.87 at the end of ten years. So, the point is to negotiate as low an escalator clause as you can up front because those increases will never go away.
3. Common Areas and Maintenance (CAM)
Common Areas and Maintenance, or CAM, are fees the landlord charges all tenants for the areas you all share, such as: public bathrooms, lobbies, parking lots, and loading docks. It also covers servicing things like the elevator or the HVAC system. Depending on the building, these costs can be significant. For example, I lease a building for a gym I own and the annual CAM fees add up to a 13th month of rent on an annual basis and we have no control over this figure. Your goal, therefore, should be to try and negotiate a lower CAM fee or have it capped or moderated in some way, especially if you are planning on signing a longer-term lease.
4. Tenant Improvement (TI)
Many times when you lease a building, you're initially getting just the utilities, bare concrete and steel bones. You then have to supply the things you need to make it into a functional office or workspace. But there is also a question of who pays for those improvements. One option is for you to pay for those improvements out of your own pocket--which keeps your lease payment the same. Your other option is to let you landlord make those tenant improvements or TI. While that might seem like the obvious answer, before you jumotothis answer: it's really just a loan your landlord is giving you. They will earn the money they invest in TI back in annual rent and increases. That can still work to your advantage if you are cash strapped, just don't make the mistake in thinking that the landlord is doing this for "free." That's why you want your initial Base Lease Payment quoted without Tennant Improvement, so the increase to cover the loan they are making is transparent.
5. Free Rent
While it might seem counterintuitive to do, you should always ask your landlord for an option to pay zero rent for a certain amount of time--especially if you are a new business that needs to time to establish a presence in the neighborhood. If you are a retail company, for example, it would be to your advantage to pay zero rent for the first six months, half rent for the next six, and then full rent by the start of your second year. This gives your business the kind of runway it needs to build up a steady cash flow where you can actually afford to pay full rent out of the earnings of the business. It's not always easy to get a landlord to give free rent, but it's always worth asking just in case. We did this in a start-up business I own and it made all the difference in the financial results in the first two years.
6. Lease Assignment
A sixth and final element to worry about when it comes to your lease is whether or not you have the power to assign that lease to someone else if you sell the business. While it might be an easy clause to overlook, especially when you're a startup, it can have a big impact on your business if the landlord gets to decide whether you can transfer your lease or not. I speak from experience. I had a deal with a business based in Boston I was selling to a big multinational company. But I didn't have the ability to assign the lease to them. That meant the landlord held the deal up for two weeks while we negotiated with him to get the new company to take over the lease, even though they were a far superior tenant. It almost blew up a very lucrative deal. Fortunately, everything worked out in the end. But all that hassle could have been avoided in the beginning if I had negotiated that clause into the lease from the start. Landlords generally don't like to give up this power, but if it's the future sale of your business at stake, you don't want to let your landlord stop you.
So, as you go about signing a lease for the home of your business, use your lawyer for help but focus your time on these six areas that can all have a significant impact on the income of your business--as well as your ability to sell it down the road.
You can find Jim at www.IncCEOProject.com